In most surveys, average defined benefit portfolios are found to outperform the average defined contribution plan account. And while that was true in Callan Associates latest “Callan DC Index” report, one category of target date fund -- 2030 funds -- performed markedly better last year than both overall DC plan assets and DB plans, presumably due to a higher average equity allocation.
But don’t get too excited. According to Callan’s report, measuring cumulative returns since 2006, target date funds lag both the average DB and DC plans, “reflecting poor performance during market downturns.” Over time and with the numbers from the financial crisis period receding, better recent performance may change that picture.
Also, most small DC plan sponsors should not worry too much about any comparisons with DB plan portfolios, according to James R. Glose of Northeast Retirement Advisors in West Seneca, NY.
Dollars flowing to target funds
Yet the popularity of target funds continues to grow. Specifically, target date funds “attracted the majority of fund flows during the fourth quarter, as well as the year as a whole,” according to Callan. For the year, target date funds attracted nearly two-thirds (63.3%) of every dollar that flowed within DC plans in Callan’s universe. “This flow data reflects participant and plan sponsor contributions, withdrawals, transfer activity, and any changes in the fund or asset-class lineup.”
What about DC plan account balances overall? They “surged” last year (up 14%) but, that was primarily due to strong investment performance. That has been the historic (since 2006, at least) source of account growth. According to the report, over the past six years, average annual investment growth (at 3.77%) tops growth in inflows (2.96%). Those inflows are still critical, however, and “attest to the importance of plan contributions in helping employees achieve their retirement savings goals.”
Here are those investment numbers: The average 2030 fund was up 13.69% last year, compared to 12.28% for the DC average for the year, and 12.67% for the average DB plan.
A note on Callan’s methodology. According to the company, The Callan DC Index is an equally weighted index tracking the cash flows and performance of nearly 80 plans (both 4019k) and other DC plan types), representing more than 800,000 defined contribution participants and over $100 billion in assets.
Regarding the DB performance comparison, Glose doesn’t mince words. If a DC plan sponsor somehow believes a higher average DB fund performance is a reason to wish they had a DB plan instead, “once they understand the how a DB plan works and the commitment involved, if they adopt a DB plan, it will be for the higher deductible contribution limits.”
DB goal: cut risk, plan deductions
With his DB clients, the investment goal of the DB plans “is to reduce risk and control returns, so that plan sponsors can plan for their targeted deductible contributions.”
The effect is actually to bring down investment returns, not the goal of large institutional funds for publicly held companies with average returns historically superior to the DC plan averages.
That occurs through diligent management of the portfolio for investment returns in to keep them in 4% to 5% range. “If we exceed that, it cuts into the plan sponsor’s deductible contribution amount. The focus of our DB plans is to provide large tax deductible contributions for the plan sponsor,” Glose says.
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